Volatility is your friend
My eye was drawn to the ever-changing numbers on my car’s fuel economy gauge as I drove to Denver. After a couple of minutes, I had to turn it off. It was very distracting. So many variables that contribute to the output, and as it flashed, it drew my attention away from what was really important — keeping my eyes on the road! I chose the particular vehicle I did for specific reasons, and it is expected that it will perform for those purposes. The car was doing what it was designed to do. There are things I can do to get better gas mileage and keep the vehicle running efficiently, and there are the inner workings that are beyond my desire to understand or capability of handling on my own.
Just as watching the fuel gauge, there is the allure of watching what the market is doing on a daily or weekly basis. Someone crosses my path — “Wow, the Dow is really down or up today.” Or “Greece, China or Timbucktoo is sure wreaking havoc with the market.” Passing comments might induce a lively conversation, but don’t let the daily tumult side track you on your journey. It will distract you from keeping your eye on the road and enjoying your journey. Like a well-maintained vehicle, you should have a portfolio designed to give you the best performance and to serve you for your desired needs and intentions. What does it look like to have a honed investment portfolio? For a non-tax sheltered vehicle, being tax-minded is paramount.
Tax gain and loss harvesting are ways to help you keep more of what you earn. It may feel counterintuitive, because the goal of investing is to make money, not lose it. With market volatility (as seems to be happening more and more) comes an opportunity to potentially improve overall after-tax returns. The ongoing challenge lies in a creating a strategy that is systematic. This includes disciplined trading, diligent tracking of your investments and detailed accounting systems. As a taxpayer, you use capital losses to offset capital gains and then remaining losses can be used to offset up to $3,000 of ordinary income each year with carry forward use in future years. This strategy reduces your annual tax bill. The wash sale rule needs to be adhered to — you can’t rebuy the same asset for 30 days. But you can get creative in selecting a similar sector stock, ETF or fund that would keep your allocation maintained.
Like a trusted car mechanic that understands the inner workings of your particular make and model, a good money manager will work will maximize the use of tools like:
Tax-lot accounting: An accounting method that tracks the purchase, sale price and cost basis of each security, then “swapping” a batch of stocks with long-term gains for a batch with smaller, short-term gains.
Gain-loss offset: Involves selling securities at a loss that have dropped in price during volatile periods to help offset gains from selling securities that have increased in price.
Delayed trading: Delaying the sale of stocks that are about to shift from a “short-term” holding to a “long term” one.
Charitable giving: Identifying the most tax-advantaged stock sales for the purpose of making charitable donations.
It is time to start looking ahead to next year’s tax bill and beyond. Some investors whose holdings have done well can consider a tactic called tax-gain harvesting. This makes the most sense for investors in the 10 percent to 15 percent tax bracket, who pay no taxes on capital gains. It might make sense to sell some investments to realize the gains tax-free. If the liquidity is not needed, the money can be immediately reinvested any way you want, even in the same security or fund that was sold. The wash-sale rule doesn’t come into play in this case. The idea here is to take gains before you move up to a tax bracket where you will be subject to capital-gains taxes.
Taxation issues are becoming more complex and require pro-active, year-round oversight. The top marginal income tax bracket is 39.6 percent. The top long-term capital gains rate is 20 percent (not including the 3.80 percent Medicare surtax). If you are younger than 65 and not dealing with Medicare yet, managing income from investment portfolios is vital for maximizing opportunities within the Affordable Care Act.
Keep your eyes on the road. Where do you want to go and what are the proper vehicles to get you there? You head in a direction and know you have to make course corrections and keep performance at its optimum. How do you want to build your team of experts to assist you on the way?
Danielle Howard is a Certified Financial Planner practitioner. Her office, Wealth By Design LLC, is in Basalt. Visit her at http://www.wealthbydesign4u.com. Advisory Services offered through Cambridge Investment Research Advisors Inc., a Registered Investment Advisor. Securities offered through Cambridge Investment Research Inc., a broker/dealer, member FINRA/SIPC. Cambridge and WBD are not affiliated.
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